The piece I wrote yesterday was intended to be mainly about codes of conduct but ended up being about the Action Aid story on ABF, judging by comments.

I have to say that I wasn’t talking specifics about the tax position at the time, I was using it as a topical example of a situation which there appears to be significant question marks and a code of conduct may have better focused resources. I’ve only read through the material once and some of commentary so these are still first impressions about the story:

One key problem I think there is with the ABF story is that there are a lot of questions about Zambian tax policy rather than international tax issues. Whilst of interest, these are Zambian domestic matters that are not necessarily exclusive to a large multinational.

For example, the loss of withholding tax relates to the double tax treaties that Zambia has agreed with Ireland and the Netherlands.

Withholding tax is always going to confuse the issue because it is essentially a timing issue, for an honest business anyway.

But what’s the purpose in levying a withholding tax on some jurisdictions rather than others?

If a withholding tax is the intended norm does the exemption for certain jurisdictions signify a reluctant quid pro quo which is now being abused? Or is it something that is seen as necessary to prevent abuse through certain jurisdictions?

If it’s the latter that receives a positive answer, does routing a payment through a particular jurisdiction achieve the policy aim? If the treaty provides one country with satisfactory safeguards, is a withholding tax considered desirable? Withholding taxes are often primarily used in combating evasion.

Ultimately, it really only matters if the withholding taxes would not be relieved in some way. If the Zambian business is profitable (presumably this will happen provided profits aren’t artificially extracted in some way) the withholding taxes would be offset against corporation tax.

Also the question of the applicable rate is a Zambian matter. If the outcome of the court case is seen as an undesirable outcome, why haven’t they tightened the law to prevent activities such as Illovo Sugar’s qualifying in part or in full? And why have they then reduced the preferential rate further without doing so?

These aren’t international issues but domestic policy issues which are within Zambia’s powers to address. That’s not to say that they aren’t an issue we can help with. But we need to look at what Zambian tax policies are trying to achieve.

If they are concerned with inward investment rather than revenue raising from this type of business, then how do we know that Illovo aren’t doing exactly what the Zambian government wants them to?

The quote that Chris Jordan offered me yesterday from a former Zambian finance minister suggests that they are more concerned with inward investment rather than the corporation tax revenue.

What this boils down to is that the only international angle relates to the costs incurred within the group. ABF say that these are at cost and if this is correct there isn’t any profit being shifted.

Further to this, if they are at cost is this an arms length transaction? Should they be higher?

The argument for this is that if the profit arises in Ireland and it is caught by South African CFC rules, South African corporation tax revenues (a higher rate than the farming rate in Zambia) are being mitigated.

An adjustment to correct that would ultimately reduce Zambian corporation tax further.

Rather inevitably, I’ve taken an interest in this now so I’ll probably correct or clarify any of these thoughts as I go along…

I agree with that. But where a company is ultimately profitable enough it becomes a timing issue.

But, I think where that point becomes important is if you’re going to have an attractive 10% rate for some activities, what are you looking to achieve. Do you want people to create trapped WHT or do you want them to work around it?

I’m not sure about this. WHT is a big deal in international tax, it’s how taxing rights on passive income are allocated to source jurisdictions.

If you’re a developing country, you start from your general rates, and the lower rate in a treaty is the carrot you offer the developed country in order to get the treaty.

We can get into whether that’s a worthwhile sacrifice (unlikely in the Zambia-Ireland case) and the politics of it all another time…I may have an answer in 3 years or so.

Some developing are getting keen on anti treaty shopping provisions, and one thing want to look at is whether they’ve managed to get them in their more recent treaties with potential treaty shopping conduit countries. But it’s not hard to define treaty shopping, and I don’t think the absence of such provisions should be a license for businesses to exploit then.

I think you’re right. As I said these are just my first thoughts on it from what I’d read. Having expressed my overall opinion on the story I thought I’d better put down my first impressions, warts and all. I genuinely hadn’t expected so many people to read that post.

I don’t work in international tax any more. Most situations I dealt with, WHT wasn’t particularly a big issue. I can see that WHT is a bigger deal for developing countries.

But that really makes me curious about the Irish treaty with Zambia.

Looking at the other treaties, Ireland appears to be the exception with regards to interest. It does seem rather at odds with the overall policy goals.

Now, to my mind that’s a more interesting story in many ways. I don’t mean to say “it’s not our problem”, but the first thing I think needs considering is whether Zambia consider it beneficial or not.

Chris Jordan says that Action Aid are lobbying in Zambia to renegotiate, but as Andrew Jackson pointed out, they shouldn’t need to lobby too hard.

It’s interesting, but I do think singling out one company isn’t necessarily the best way to highlight it. But I don’t know what alternatives were considered.

The question has got to be why Zambia decided to give Ireland such a nice treaty. I’d be surprised if it were because of Ireland’s economic muscle, given what Zambia agreed with the UK and other major nations.

If Zambia simply thought that Irish trade would never be big enough for nil WHT to be a problem, then is that not just a lack of foresight on Zambia’s part at worst? It’s quite possibly a conscious effort by Zambia to encourage Irish trade, in which case ABF is arguably fulfilling Zambia’s aims.

You’re both right, this treaty is a mystery. The standard theory would be that the WHT sacrifice is justified by the CIT gains from inward investment, but hard to see why they’d expect so much from Ireland. It’s an old treaty, dating from before Ireland had its low CIT rate (and before EU directives lowered WHT rates between member states?) so I guess the treaty shopping risk wasn’t so big then. I’ll write something next week if I find time on the state of art in treaties.

Kudos to Ben for putting some thoughts out there and then letting commenters change his thinking. I should do more of that.

One thing I notice is that the UK DTA also has the nil WHT rate on management fees: the big difference between the UK and Ireland is royalties and interest.

If one (charitably?) assumes that the Irish company is actually providing some services, the WHT position is therefore the same as if it were UK-resident. Which, for ABF, would not seem to be an unreasonable starting point.

So that side of it doesn’t look so much like treaty shopping, though of course interest and dividends are a different issue. No need to go shopping if you’ve already got the best deal going.

You’re absolutely right that the report deals with a number of Zambian tax policy issues, and there are a substantial set of recommendations at the end for the Zambian government. The report is a joint ActionAid UK/ActionAid Zambia report, so we’re looking at both national and international tax issues.

That said, the way that DTAs work (or don’t) for developing countries is surely a core international tax issue – one area that’s going to be dealt with in the forthcoming OECD ‘base erosion and profit shifting’ work on international tax standards. One reason we found this case important was precisely because it highlighted aspects of the international tax system *other* than transfer pricing, which haven’t had much of an airing but which may be just as important for developing countries.

Andrew – the point about the UK treaty rate is interesting; but in this case, as the report notes, we were told by those responsible for dealing with Illovo Sugar Ireland’s paperwork that management services were being provided primarily from South Africa, home to Illovo Sugar Ltd and the centre of the Illovo group’s sugar operations, not the UK. The ZM-SA treaty rate on management fees is the full domestic rate – previously 15%, now rising to 20%; routing through Ireland avoids this.

As you say, a number of jurisdictions would cancel WHT on management fees if used as a conduit. In this case Ireland isn’t being used as a conduit only for management fees, but for interest payments to non-resident banks and (pre-2008) for dividends. Ireland and Kenya are the only two jurisdictions whose DTAs with Zambia will cancel all WHT.

Finally, Ben’s question is an important one about whether companies taking advantage of the 0% WHT in the Ireland-Zambia treaty is simply the intended effect of the treaty. This is a key question for whether we’re talking here about corporate tax avoidance or tax/investment policy. But in this case I think it’s impossible to defend the idea that this is the intended effect of the treaty. Favourable treaty rates in DTAs with particular jurisdictions are intended to incentivise investment from those jurisdictions. There’s no real Irish investment happening here: Zambia Sugar was bought by a South African company, and now a UK one, with ownership simply conveniently routed through Ireland. The same is true of ‘dog-legging’ the company’s bank loans through Ireland: there’s no investment from Irish banks, but from U.S. and South African banks. If Zambia wants to incentivise investment from the U.S. and South Africa by lowering WHT rates in those treaties that’s entirely it’s prerogative (it hasn’t done so). Instead what’s happening here is that a company is using an old treaty with a completely separate jurisdiction (without robust anti-treaty-shopping/limitation of benefits provisions) for a purpose for which it was never intended.

I’d assume that if a charge would arise without the treaty, then the intention of the treaty should be read fairly narrowly. That would explain why people keep bringing in limitation of benefits clauses these days. But this is a specialist area I’m not too competent on.

I take it that you’d argue that a more appropriate situation would be for the Zambian company to pay the South African one directly for the services which it obtains? This would then have the incidental effect of leaving the 15% WHT in place.

The questions this leaves me are:

– Given the mobility of capital these days, can one really look through an investment and say “this one comes from Ruritania”?

– On that note, if one assumes that an SPV for providing services to Zambia is appropriate, what factors should determine where one puts it? Indeed, what factors should be taken into account in deciding whether an SPV is appropriate? I generally assume that taking an extra step is a pointer towards avoidance of something, but that’s as true of say insurance regulations, or indeed a lamp-post, as it is of tax.

– Are different tax rates in different treaties appropriate any more, given the ability to treaty shop? Or should limitation of benefits rules more generally allow one to look through to an entity’s parent in a reverse-CFC sort of way? I’m a bit out of touch with the detail of DTAs: most of my clients these days are at the simpler (sic) end of them.

– What is a sensible level of WHT on management fees, given that it gets levied on gross income not on profit, and unlike interest, dividends and royalties there are usually significant costs associated with providingtechnical services? Even 10% seems high for that sort of thing: it almost feels as though they’re aimed at the sort of “management services” that have no cost because they don’t exist, which these days of transfer pricing shouldn’t realy exist any more.

I don’t really have any answers at the moment, but it’s good to get some questions to think about 🙂

Thanks Andrew – these are all super-interesting questions. Here’s my stab at three of them:

– Mobility of capital: I suspect the question is different for management fees vs. investment income.

In the case of investment income routed through the Irish company, the source of the investment is very clear: it’s on the mortgage documentation filed publicly with the Irish company registry. There’s only two steps: the loans come from the UK branches/subsidiaries of two banks, and all of the interest paid from Zambia Sugar to Illovo Sugar Ireland is paid on to the banks. There’s no investment raised from Ireland or Irish bank branches: the payments are just routed via Ireland, it seems to avoid WHT.

– Different treaty rates: I think you’re right that there’s an important argument to be had about harmonizing tax treaty rates and whether it would reduce treaty abuse (although I’m not convinced that harmonization would be desirable for all countries); but that’s a different question than whether it’s legitimate to avoid WHT through treaty shopping. The position of international tax standards is clear here. The OECD model treaty commentary says the use of conduit companies is “abuse”: paras 9-20 of the Commentary on Article 1 notes a range of beneficial ownership clauses, look-through, limitation-of-benefits measures and ‘subject to tax’ conditions to tackle it.

– Level of WHT on management fees: I agree again that there’s an important argument to be had about their level, given that they’re charged gross rather than net. But again I’d say that’s a different argument to the question of the propriety of avoiding them; just as I’m not sure I’d get very far with HMRC if I argued that an avoidance scheme was justified because I thought the rate of income tax was too high…

On the wider argument: it’s clear that for many developing countries withholding taxes are not just a defensive measure against profit-shifting through ‘diversionary income’ or artificial payments; they’re also an important way of taxing real income that arises within their jurisdictions. In Zambia’s case, that’s why WHT is levied on interest, management and consultancy fees paid to non-related-parties as well as to related parties. Perhaps that militates towards a lower rate for demonstrably ‘real’ services vs. e.g. a fixed management fee of e.g. 2% turnover? Or perhaps developing countries might wish to maintain significant WHT in order to encourage companies to locate higher-value functions like management and other specialist services in their countries, as part of their wider industrial strategies?

But again, this is a separate argument to the legitimacy of avoiding the taxes as they currently stand; and a separate argument to the question of the substance of the fees in this case (as you can see from our report, we are nonetheless puzzled about why over 20% profit is being booked *in Ireland* on management fees when there appears to be no staff or presence in Ireland).

The specifics of this case aside, I think it will be interesting to see how/whether your larger questions about the levels and harmonzation of treaty rates are dealt with in the current OECD BEPS process?